Ethan Allen Interiors Inc Q4 FY2023 Earnings Call

Good afternoon, and welcome to the Ethan Allen Fiscal 2023 Fourth Quarter Analyst Conference Call. A question-and-answer session will follow the prepared remarks. Please note this conference is being recorded. It is now my pleasure to introduce your host, Matt McNulty, Senior Vice President, Chief Financial Officer and Treasurer. Thank you. You may begin.

Thank you, Darryl. Good afternoon and thank you for joining us today to discuss Ethan Allen's fiscal 2023 and fourth quarter results. With me today is Farooq Kathwari, our Chairman, President, and CEO. Mr. Kathwari will open and close our prepared remarks, while I will speak to our financial performance midway through. After our prepared remarks, we will then open the call for your questions. Before we begin, I'd like to remind the audience that this call is being recorded and webcast live under the News and Events tab on the Investor Relations page of our ethanallen.com website. There you will find a copy of our press release, which contains reconciliations of non-GAAP financial measures referred to in this release and on this call. A replay of today's call will also be made available via phone and on our website. Our comments today may include forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings for a complete review of those risks. The company assumes no obligation to update or revise any forward-looking matters discussed during this call. With that, I'm pleased to now turn the call over to Mr. Kathwari.

Thanks, Matt. Thank you for participating in our fiscal 2023 and fourth quarter financial and operating results. As we reported, we had strong financial results for our fiscal year and fourth quarter ended June 30, 2023. For the year, sales of $791.4 million, gross margin of 60.7%, adjusted operating income of $133.5 million, which is 16.9% of sales and adjusted earnings per share of $4.03 compared to $3.93 in the previous year. Our fiscal fourth quarter was also strong with adjusted operating income of $30.6 million for an operating margin of 16.3%. We have continued to generate strong cash and as of June 30, 2023 had cash and investments of $172.7 million and no debt. We are also pleased that yesterday, our Board approved a regular quarterly cash dividend of $0.36 per share and a special cash dividend of $0.50 per share, both payable August 31st. As expected, the focus and very high demand of consumers on the home during the COVID-19 pandemic has moderated. We are well-positioned to continue our progress. After Matt provides a brief overview of our financial results, I will provide an overview of our focus to continue our strong operating and financial results. Matt?

Thank you, Mr. Kathwari. As a reminder, we present our financial results on both a GAAP and non-GAAP basis. Non-GAAP results include restructuring initiatives, impairments, and other corporate actions and are further detailed in our press release. We believe the non-GAAP presentation better reflects underlying operating trends and performance of the business. Our financial results for the fiscal 2023 full year and fourth quarter ended June 30th are highlighted by strong growth in operating margins, improving lead-times from decreasing backlog, disciplined cost and expense controls, strong operating cash flow, and a robust balance sheet. As we operate in a post-COVID-19 era, our operations produced strong financial results, which I will now discuss. Our fiscal 2023 consolidated net sales of $791.4 million were lower than last year by 3.2%. Our fourth quarter consolidated net sales totaled $187.4 million, a decrease of 18.4% due to lower delivered unit volume from softening order demand and reduced manufacturing production from lower backlog. Sales in the fourth quarter a year ago set a near record pace leading to a difficult comparison. Compared to the fourth quarter of fiscal 2019, which is pre-pandemic and more reflective of historical norms, our consolidated net sales were up 1.9%. Wholesale segment written orders during fiscal 2023 were 9% lower compared to last year, but only 2.1% lower than fiscal 2019. For the quarter, our wholesale orders were down 14.7% to last year and were 2.5% lower than our pre-pandemic fourth quarter of 2019. Retail segment orders were 12.3% lower in fiscal 2023 when compared to last year, and down 12.5% for the quarter, primarily due to a strong prior year comparable and a reduction of consumer focus on the home. When compared to 2019, retail orders for the full year were up 0.8%, while our quarterly orders were down 1.2%. We ended the fiscal 2023 year with wholesale backlog of $74 million, down 27.7% from a year ago as we were able to reduce the number of weeks of backlog. However, our wholesale backlog still remains higher than pre-pandemic levels, and our teams are effectively managing the business to work through this order backlog and to service our customers. For the full fiscal 2023 year, our consolidated gross margin was 60.7%, a 140-basis point improvement over last year. In the just completed fourth quarter, consolidated gross margin was 61.5%, our ninth consecutive quarter that consolidated gross margin exceeded 58%. When compared to last year, our quarterly consolidated gross margin was up 330 basis points due to favorable sales mix, disciplined promotional activity and lower input costs including reduced inbound freight and raw material costs, partially offset by lower delivered unit volume. Retail sales, which carry a higher gross margin increased to 83.4% of fourth quarter consolidated sales, up from 82.1% last year. For the 2023 fiscal year, our adjusted operating margin was 16.9%, a 50 basis point improvement over last year as we carefully managed expenses in the declining net sales environment. Fourth quarter adjusted operating income and margin was 16.3%, down from 18.5% last year due to lower consolidated net sales, higher retail delivery and health insurance costs and new product display, merchandising and sample costs, partially offset by gross margin expansion and our ability to maintain a disciplined approach to cost savings and expense control. Our SG&A expenses decreased 7.6% and equaled 45.1% of net sales, which is an increase from 39.8% last year due to fixed cost deleveraging on lower sales. On a full year basis, adjusted diluted EPS rose 2.5% to $4.03. For the fourth quarter, our adjusted diluted EPS was $0.96 compared to $1.25 last year. Our effective tax rate was 25% for the full year and 23.6% for the fourth quarter, which varies from the 21% federal statutory rate primarily due to state taxes. Now, turning to our liquidity and capital resources. We ended our fiscal year with a strong balance sheet, including cash and investments of $172.7 million as of June 30 and no outstanding debt. We generated $26.3 million of cash from operating activities during the quarter, bringing our total fiscal year amount up to $100.7 million, a 45.1% increase over last year. This growth was driven by strong profit performance and a reduction in inventory carrying levels and accounts receivable, partially offset by a decline in customer deposits. Our inventory levels decreased $27.3 million since the start of the fiscal year as we restore our operating inventory levels to more historical norms as backlog decreases while also ensuring appropriate amounts of inventory are on hand to service our customers. Capital expenditures were $13.9 million for the year, including $3.2 million during the fourth quarter as we continue to invest capital in manufacturing, retail, technology, and infrastructure. We also continued our practice of returning capital to shareholders in the form of cash dividends. In April, our Board increased the regular quarterly cash dividend by 12.5% to $0.36 per share, which was subsequently paid in May and brought our fiscal 2023 dividends paid total to $46.4 million. Also, as just announced in our earnings release, our Board declared a special cash dividend of $0.50 per share in addition to our regular quarterly cash dividend of $0.36 per share, both of which will be paid on August 31st. We have paid a special cash dividend each of the past three years and have paid an annual cash dividend every year since 1996. In summary, our vertically integrated business delivered strong fiscal 2023 operating results during a period marked by industry-wide softer demand and challenging headwinds. We achieved these positive results and generated strong cash flows while protecting our margin gains through disciplined investments and solid execution. As we move into fiscal 2024, we must continue to carefully manage our expense structure while investing in growth initiatives that we believe will further our business. With that, I will turn the call back over to Mr. Kathwari.

Thank you, Matt. As I mentioned, we and our industry greatly benefited from the consumer focus on the home during the COVID-19 pandemic and as expected, consumer focus is now on many other areas as well. As we noted in our press release, we are very well positioned. During the last three years, we have greatly strengthened our enterprise in several important areas, including the following; strengthening talent. We have strong talent in our various areas from product development, marketing, manufacturing, logistics, retail, technology, and operations. Our product offerings and marketing have been enhanced. Our product programs under the umbrella of classics with a modern perspective are being introduced to our network. Our marketing has been greatly expanded, especially utilizing digital mediums. The repositioning of our retail network. We are in the process of launching our refreshed projections under the umbrella of Interior Design Destination. Our plan is to complete the launch in our 175 North American design centers during the next six months. This provides us great opportunity to reach our clients and is also a strong motivation for our interior design team. As you know, we have the largest interior design network. We are pleased and honored that last week in a study by Newsweek, we were named One of America's Top 10 Retailers, including recognition as number one retailer in the premium furniture category. Continued strengthening of our manufacturing and logistics. We have continued to invest in our 10 North American manufacturing operations, which produced about 75% of our products with 75% of them custom. Our national and retail logistics continue to be enhanced. We provide excellent and consistent service at one delivered price to our customers throughout North America. Technology, our focus and continued investments in technology have been a game-changer both in providing excellent interior design service, combined with technology, and in the efficiency of our manufacturing and logistics operations. And finally, we remain focused on being socially responsible as it is an important part of our business, our culture and to the communities in which we serve and operate in. As we mentioned in our press release, we remain cautiously optimistic. Operator, we are now pleased to open the call for any questions and comments.

Thank you. We will now be conducting a question-and-answer session. Our first questions come from the line of Brad Thomas with KeyBanc Capital Markets. Please proceed with your questions.

Hello, Brad, is it you?

It is me here. Yes, hi good afternoon Farooq and good afternoon Matt. How are you all?

Good to hear you, Brad, after some time. And you are doing well?

I'm doing well, I'm thrilled to not have another earnings conflict here during this call today. So, good to hear you live, Farooq. Well, thanks for all the prepared commentary. I was wondering if you could talk a little bit about the cadence of the business from a written perspective, with a little bit of a slowdown from what you posted in the March quarter. I was wondering if you could talk about some of the dynamics behind that? Did you change at all? How promotional were you? Is it getting more competitive? Did the consumers seem to just pause and how you're thinking about the cadence of orders as we look forward here?

Yes, we previously experienced very high levels of incoming orders over the last three years, reflecting significant consumer interest. This interest has now returned to a more normal state, similar to the conditions we observed in fiscal 2019 before COVID. Even with this shift, our backlogs remain higher than they were in 2019, which is encouraging. Additionally, we've become much more efficient across all levels of our operations. For instance, technology has played a crucial role in enhancing both efficiency and productivity in manufacturing and retail. When comparing to 2019, we now have significantly fewer interior designers generating more business due to technology. Similarly, our manufacturing capabilities have improved, going from 30 plants 25 to 30 years ago to just 10 today, all operating very efficiently thanks to a combination of talented people and technology. While our business has moderated, it's worth noting that despite having lower sales than last fiscal year, our gross margins and operating income have improved. Moving forward, we expect to continue operating efficiently and effectively in terms of both gross margin and operating income.

And that's a great segue to my follow-up question there. The gross margin, obviously, very strong. I know some of that is a function of channel mix and on where the sales come from. But how are you all thinking about the puts and takes on gross margin as we think about the next year?

I think the gross margin is clearly influenced by production and sales levels. As a vertically integrated company with our own manufacturing, we experience advantages from higher volumes. Conversely, lower volumes negatively affect our gross margins. Taking all of this into account, we believe we will sustain our current position due to the efficiencies we have implemented.

Got it. I appreciate it. Thanks so much, Farooq.

All right. Thanks very much. It's good to hear your voice. I want to mention that the team may not fully realize it, but I believe you were present when we took this company public 30 years ago, correct?

Quite that far. Going through the great financial crisis, but not quite that far. Yes.

Okay, you're still young. All right.

That’s right.

All right, Darryl, please go ahead.

Thank you. Our next questions come from the line of Cristina Fernández with Telsey Advisory Group. Please proceed with your question.

Hello Cristina, how are you?

Hi, I'm doing well. Good afternoon. I wanted to follow up on Brad's question about demand. Can you comment on how volatile these trends are? Are you seeing similar trends week-to-week or month-to-month, or is there significant volatility in the market? I was also curious about the comparison between ticket sales and traffic— is ticket sales outpacing traffic?

Yes, that's a good question. We're living in interesting times. This past summer, we've noticed that people were going on vacations and not staying home, which is quite different from last year. So, what we are observing is that this summer, there has been a greater impact from people engaging in various activities. Additionally, many people have purchased products for their homes. As summer comes to an end, we anticipate that people will return to normal levels of visiting our design centers, albeit possibly not as high as the last three years. However, we do expect to see better traffic compared to the pre-COVID period.

I have another question about the gross margin. How much of a benefit are you seeing from input costs, including transportation, freight, and raw materials compared to last year?

Yes, our gross margins and operating margins are crucial areas affected by freight costs and product delivery. It's important to note that we deliver our products at a consistent price across the United States and Canada. Over the past three years, transportation costs in the U.S. were unusually high, with the cost of shipping a container from Indonesia or East Asia rising from $3,000 to $30,000, though it has since decreased. Delivery costs within the U.S. at the retail level were also elevated due to domestic transportation, with the cost of shipping a trailer across the country tripling, but that is returning to normal levels. To address your question, we are experiencing a positive impact on our margins at both the retail and manufacturing levels due to cost reductions. Additionally, as a manufacturer, we have seen lumber costs spike but are now approaching pre-COVID levels. While we will feel the impact of slightly lower deliveries, we are benefiting from the decline in costs, whether it pertains to raw materials or freight. This affects both our manufacturing and retail sectors, as much of our freight is included in our operating expenses and some is accounted for in our manufacturing costs.

That's helpful color. Thank you. And then the last question I had was on the store refreshes, how many have you done so far? I know you did the Danbury store at your headquarters. And those that have been completed, how are they performing relative to the rest of the chain and the ones that have not been touched?

Yes, it's a very, very important and good question. I believe you came to the Danbury design center; you saw it. We are in the process right now. We have not completed any as yet completely, but they're all in the process of getting completed. And I would say the process of getting them completed because it needed products. It needed also the work in each of the design centers, needed painting, some electrical work, and all those kinds of things. That is being done right now. At this phase, we are in the process of updating the interiors and in some cases, the exteriors of our design centers and starting in about, I would say, four to six weeks, they will start getting products, which is being made and getting ready. So, as I said, within three to four months, most of the design centers would have received the product. And the objective is, which is something that we couldn't have said that five years back that the interior projection that you saw in Danbury is the projection that we're going to have nationally in 175 design centers. The other reason that we are able to do it today is that technology has played a tremendously important role. In the past, we had to have the product in the design center or the store for people to see. Today, with our digital technology and virtual reality, our designers can develop and they do develop designs for the consumer with all kinds of colors and designs and products. That is a game-changer. So, to answer your question, I think you'll start seeing it in the next two to three months, the process will start, and our objective is most of them will be completed in about six months.

Great. Thank you.

All right. Thanks very much. And any other questions or comments?

Thank you. I see no further questions in the queue. So I'll hand the call back over to Farooq Kathwari for any closing comments.

All right. Darryl, thank you, and thank you, everybody, for being on the call. These are interesting times, and the good news is that we are very, very well-positioned and we look forward to continuing our progress and our growth. So, thank you very much for participating in this call.

Thank you. That does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.